The Facebook IPO

How to Trade Facebook Stock Options

Mark Zuckerberg
David Paul Morris | Bloomberg | Getty Images

Like Facebook shares, but can't get near them? There are always options.

So. You like Facebook shares. Get in line. It’s next to impossible for individual investors to obtain shares at the initial offering price, so if you really want in on the stock you need to think about alternatives. You could invest in another social network, or a basket of technology stocks — or wade into stock options.

Options on the stock could be available within days of the Facebook IPO. That’s a good thing if you have strong convictions about the company’s direction — and a strong enough stomach for the options market. But options are not for amateurs or the faint of heart, and it’s a good idea to stop and consider before you jump into these instruments.

“The hype surrounding this IPO is rarely seen,” says Edward Reinhart, managing partner at Capital Advisors Wealth Management. “I hope individual investors take a deep breath and step back while the steam escapes a bit. My fear is many retail investors will dive head-first, rather than test the waters.”

If you decide you’re still interested in Facebook options, here are the details.

Options on newly issued stocks can start trading when they meet standards set by the options exchanges. At the CBOE, for example, a spokeswoman outlines the rules as follows:

· Minimum of 7,000,000 shares of the underlying security must be owned by people other than officers, directors and shareholders with more than 10 percent of the stock. 

· Minimum of 2,000 stockholders

· Trading volume has been at least 2,400,000 shares in the preceding 12 months — i.e., it needs to reach cumulative trading volume of 2,400,000. If they hit that volume level in a day, or two, or three, that would qualify.

· Market price per share has been at least $3.00 for the previous five consecutive business days preceding the date on which a certificate is submitted to the Options Clearing Corporation for listing and trading.

Facebook shares seem to be on track to meet these standards pretty quickly, given the feverish interest in the offering and the current tentative pricing. In fact, a spokeswoman for the CBOE says that "if everything goes as planned, CBOE and C2 could open as early as May 29." And unlike stocks, options can be traded on multiple exchanges, which should boost their availability.

The next question, then, is how you should trade Facebook options.

Andrew Stoltmann, a Chicago-based securities lawyer, expresses wariness of option trading for individual investors, describing it as “a little bit like Russian roulette.” But certain strategies are less risky than others, he adds.

“If someone wants to do a covered call strategy, fantastic. But with naked options, the risk increases exponentially,” he says.

(Translation: if you own Facebook shares and you sell calls on them — presumably because you think the stock will be flat for a while and then rise - you are protecting yourself on the downside but limiting your potential to profit if the stock rises before the call options expire. But if you just buy or sell Facebook options without owning the stock, that’s a much more risky proposition because your potential losses are much greater.)

Michael Pachter, a research analyst at Wedbush Securities, offers another potential approach. Pachter argues that one reason Facebook is going public now is to enable longtime investors to cash out before the end of the year, when capital gains rates could increase – possibly substantially. So Pachter thinks options might be a way to trade on potential selling pressure when the lockup period for those investors comes to an end.

“I’m really curious to see how the options price" after the unlock, he says. “There should be a lot of selling pressure. Your tax rate is going up ten percentage points.”

A long shot? Perhaps. But Pachter believes he has supporting evidence: “Look at Eduardo Saverin,” he says. Saverin, you may recall, is a Facebook co-founder who recently renounced his U.S. citizenship and now resides in Singapore, where there is no capital gains tax.